MONETARY POLICY REPORT

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MONETARY

POLICY REPORT

WITH FINANCIAL STABILITY ASSESSMENT

2 | 21

JUNE

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Editor: Øystein Olsen

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This Monetary Policy Report is based on information in the period to 11 June 2021, with the exception of Monetary policy assessment, which is based on information in the period to the Committee’s meeting on 16 June 2021. The Report was published on 17 June 2021 and is available at www.norges-bank.no.

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targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances. Monetary policy objectives and trade-offs are discussed in a box on page 51.

IMPLEMENTATION

Norges Bank sets its policy rate with the aim of stabilising inflation around the target in the medium term. The horizon will depend on the shocks to which the economy is exposed and the effects on the outlook for inflation and the real economy. In its conduct of monetary policy, Norges Bank takes into account indicators of underlying consumer price inflation.

DECISION PROCESS

The policy rate is set by Norges Bank’s Monetary Policy and Financial Stability Committee. Policy rate decisions are normally taken at the Committee’s monetary policy meetings. The Committee holds eight monetary policy meetings per year. The Monetary Policy Report is published four times a year in connection with four of the monetary policy meetings. Prior to publication, several seminars and meetings are held at which analyses are presented to the Committee and economic developments, the balance of risks and the monetary policy stance are deliberated. On the basis of the analyses and deliberations, the Committee assesses future interest rate developments. The final policy rate decision is made on the day prior to the publication of the Report. The Committee’s assessment of the economic outlook and monetary policy is presented in “Monetary policy assessment” in the Monetary Policy Report.

REPORTING

Norges Bank places emphasis on transparency in its monetary policy communication. The Bank reports on the conduct of monetary policy in its Annual Report. The assessments on which interest rate setting is based are published regularly in the Monetary Policy Report and elsewhere.

Countercyclical capital buffer

The objective of the countercyclical capital buffer is to bolster banks’ resilience and to lessen the ampli- fying effects of bank lending during downturns. The Ministry of Finance sets the level of the buffer four times a year. Norges Bank draws up a decision basis and provides advice to the Ministry regarding the level of the buffer. The advice is submitted to the Ministry of Finance in connection with the publication of Norges Bank’s Monetary Policy Report. The advice is published when the Ministry of Finance has made its decision. Norges Bank will recommend that the buffer rate should be increased when financial imbalances are building up or have built up. The buffer rate may be reduced in the event of an economic down- turn and large bank losses, with a view to mitigating the procyclical effects of tighter bank lending. The buffer rate shall ordinarily be between 0% and 2.5% of banks’ risk-weighted assets, but in special circum- stances may be set higher.

Decision-making process for Monetary Policy Report 2/21

At its meetings on 28 May and 8 June, the Committee discussed the economic outlook, the monetary policy stance and the buffer rate. On 16 June, the Committee made its decision on the policy rate and approved its advice to the Ministry of Finance on the buffer rate, on the basis of the deliberations and a recommendation from Norges Bank staff.

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Monetary policy assessment

Activity in the Norwegian economy has picked up after the sharp fall in spring 2020, but higher Covid infection rates and stricter measures to contain it held back the recovery at the beginning of 2021. Since the March 2021 Monetary Policy Report, infection rates have declined and the pace of vaccination has accelerated. The authorities have begun a gradual reopening of society, and unemployment has fallen. Further easing of Covid-related restrictions will help a return to more normal economic conditions. This suggests that it will soon be appropriate to raise the policy rate from its current level.

Norges Bank’s Monetary Policy and Financial Stability Committee decided to keep the policy rate unchanged at 0% at the monetary policy meeting on 16 June. In the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised in September.

Reopening of society is underway in many countries

Since the end of 2020, high infection rates and tighter Covid-related restrictions have weighed on economic activity among Norway’s trading partners. In both the euro area and the UK, activity fell in 2021 Q1, while US activity was lifted by measures such as direct government payments to a large portion of US citizens. Overall activity among trading partners in Q1 was higher than projected in the March Report. Vaccination cover- age in the US and many European countries is high, and since the end of April, infection rates have declined. This has allowed a gradual reopening of society in a number of countries. The easing of Covid-related restrictions will lift economic growth among trading partners in the coming quarters, and activity levels are expected to return to pre-pandemic levels in the course of autumn. In several emerging economies, especially India, infection rates have been high, but have recently declined there as well. New, more infectious virus variants still create uncertainty about the economic outlook.

Chart A Fewer cases among trading partners

Seven-day moving average of new cases per 100 000 inhabitants

Feb-20 Apr-20 Jun-20 Aug-20 Oct-20 Dec-20 Feb-21 Apr-21 Jun-21 0

20 40 60 80 100 120

0 20 40 60 80 100 120

US Euro area UK Sweden Norway

Sources: Refinitiv Datastream and Norges Bank

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Covid-related restrictions and supply problems during the pandemic have pushed up freight rates and commodity and producer prices. Underlying inflation among trading partners has been higher than projected in the March Report, and inflation expectations have risen. Overall consumer price inflation has risen sharply in a number of countries, but there are still prospects for moderate underlying inflation globally in the coming years.

The major central banks have not communicated material changes to monetary policy since March. Market-implied policy rate expectations among Norway’s trading partners have fallen a little. There are still expectations that policy rates will remain close to zero for some time ahead. Advanced economy equity markets have risen further since March.

Long-term interest rates have moved down slightly in the US but are little changed in the euro area.

Oil and gas prices have risen since the March Report. Futures prices have also increased but still indicate some decline in both oil and gas prices in the coming years. The krone exchange rate, as measured by the import-weighted index I-44, is broadly unchanged since March, in line with the projections in the March Report.

Chart B Higher inflation among trading partners Underlying inflation. Twelve-month change. Percent

2015 2016 2017 2018 2019 2020 2021

0 1 2 3 4

US Euro area UK Sweden

Source: Refinitiv Datastream

Chart C Oil and gas prices have risen since March Oil. USD per barrel. Natural gas. USD per MMBtu

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

2 4 6 8 10 12

0 20 40 60 80 100 120

Oil (r.h.s.) Natural gas (l.h.s.) Futures prices MPR 2/21 Futures prices MPR 1/21

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MONETARY POLICY ASSESSMENT

Norwegian money market premiums have fallen and are lower than previously projected, but are expected to edge up again through autumn. Residential mortgage rates are approximately at the same level as in March. Market-implied rates indicate expectations that the policy rate will be raised gradually from autumn.

Easing of Covid-related restrictions lifts growth in Norway

After falling sharply in spring 2020, economic activity in Norway picked up through the rest of the year. The recovery stalled through autumn when infection rates rose again.

Since the beginning of 2021, higher infection rates and tighter Covid-related restrictions have dampened activity further, and mainland GDP fell in 2021 Q1. The decline was most pronounced in services particularly affected by Covid-related restrictions, such as culture, hotels, restaurants, transport and some retail trade segments in a number of municipalities. Tighter travel restrictions have affected firms’ access to foreign labour, which has likely dampened output in manufacturing and construction. Overall activity rose a little again in April, but GDP was still 2.6% lower than prior to the pandemic, which was somewhat lower than projected in the March Report.

Through spring, infection rates in Norway have declined, and the authorities have again relaxed Covid-related restrictions. The pace of vaccination has picked up, and there are prospects that much of the adult population will be vaccinated in the course of summer.

The reopening of society is expected to give a boost to economic activity, especially in service industries. The enterprises in Norges Bank’s Regional Network expect solid growth in all sectors in the coming six months, particularly in household services.

Households have accumulated substantial savings over a long period of limited spending options, providing room for strong consumption growth. Card transaction data indicate that household consumption has jumped up recently. The investment plans of Regional Network enterprises indicate that mainland investment in the coming year will be higher than projected. Petroleum investment also appears to be somewhat higher ahead than expected earlier.

Tighter Covid-related restrictions led to an increase in the number of furloughed workers through winter, but unemployment has come down through spring and is now slightly lower than projected in the March Report. Long-term unemployment has remained high.

Capacity utilisation appears to be somewhat higher than projected in March. Owing to the pandemic’s uneven impact on different sectors, it is difficult to assess the pressures in the economy overall.

Chart D Lower unemployment

Registered fully unemployed as a share of the labour force. Seasonally adjusted. Percent

2015 2016 2017 2018 2019 2020 2021

0 2 4 6 8 10 12

fakeLegend1

Source: Norwegian Labour and Welfare Administration (NAV)

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Public support measures so far in 2021 have been more extensive than the Government assumed in the National Budget in autumn 2020. Further extensions of existing support schemes for households and businesses have been proposed in the Revised National Budget for 2021. Under the revised budget, public spending in 2021 will be higher than assumed in the March Report.

Over the past year, house prices have risen sharply, and housing market turnover has been high. Since the March Report, house price inflation has moderated and has been a little lower than projected. Household credit growth has also been slightly lower than expected.

Lower inflation

The underlying rise in prices measured by the consumer price index (CPI) adjusted for tax changes and excluding energy products (CPI-ATE) picked up through spring and summer 2020. CPI-ATE inflation has since declined in pace with the fall in imported goods inflation. In May, the 12-month rise in the CPI-ATE was 1.5%, which was lower than pro- jected in the March Report. According to Norges Bank’s Expectations Survey, longer-term inflation expectations lie close to the 2% inflation target.

Higher energy prices contributed to a marked increase in 12-month CPI inflation towards the end of 2020 and into 2021. In recent months, CPI inflation has again come down a little. In May, the 12-month rise was 2.7%, which was lower than projected. Futures prices for electricity and fuel indicate that CPI inflation will moderate further through summer.

Average annual wages rose by 3.1% in 2020. A marked decline in the number of employees in low-wage sectors contributed to lifting the average wage level in 2020. With the reopening of society, many low-wage employees will return to work. This will lead to a reversal of the compositional effects, and as a result, growth in the average wage level in 2021 will likely be lower than in 2020. The norm for this year’s wage negotiation between the Norwegian Confederation of Trade Unions (LO) and the Confederation of Norwegian Enterprise (NHO) was 2.7%. The other wage negotiations that have been concluded have agreed on a wage increase close to this norm. Current wage statistics and signals from expectations surveys suggest that wage growth in 2021 will be a little higher than pro- jected in the March Report. The outlook for wage and price inflation ahead is uncertain, partly owing to the potential emergence of bottlenecks and wage and price pressures as the economy reopens.

Chart E Inflation has slowed

CPI and CPI-ATE. Twelve-month change. Percent

Jan-18 May-18 Sep-18 Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21 May-21 0

1 2 3 4

0 1 2 3

4 CPI

CPI-ATE

Source: Statistics Norway

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MONETARY POLICY ASSESSMENT

Rate hike in September

The operational target of monetary policy is annual consumer price inflation of close to 2% over time. Inflation targeting shall be forward-looking and flexible, so that it can contribute to high and stable output and employment and to countering the build-up of financial imbalances.

At the beginning of the year, higher infection rates and tighter Covid-related restrictions were holding back the recovery of the Norwegian economy. Through spring, the pace of vaccination has accelerated, and the authorities have begun a gradual reopening of society. Unemployment has fallen but remains high. There is still uncertainty regarding the evolution of the pandemic, but economic activity now seems to be rebounding sharply and somewhat faster than projected earlier.

Underlying inflation has slowed and is now below the 2% target. Higher global inflation and inflation expectations are creating uncertainty about inflation ahead. However, the krone appreciation since 2020 and prospects for moderate wage growth suggest that inflation in Norway will remain below target in the coming years. As long as capacity utilisation is rising, there is limited risk of inflation becoming too low.

In considering the trade-offs facing monetary policy, the Committee placed weight on the contribution of low interest rates to speeding up the return to more normal output

Chart F Low policy rate helps to achieve the objectives of monetary policy

Policy rate. Percent Output gap. Percent

2015 2017 2019 2021 2023

0 1 2

2015 2017 2019 2021 2023

0 0

3 The output gap measures the percentage deviation between mainland GDP and estimated potential mainland GDP. CPI-ATE: CPI adjusted for tax changes and

CPI. Four-quarter change. Percent CPI-ATE. Four-quarter change. Percent

2015 2017 2019 2021 2023

0 1 2 3 4 5

2015 2017 2019 2021 2023

0 1 2 3 4 5

2015 2017 2019 2021 2023

0 1 2 3 4 5

Projections MPR 2/21 Projections MPR 1/21 Inflation target

2015 2017 2019 2021 2023

0 1 2 3 4 5

Sources: Statistics Norway and Norges Bank

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and employment levels. This reduces the risk of unemployment becoming entrenched at a high level and helps return inflation towards the target. At the same time, a long period of low interest rates increases the risk of a build-up of financial imbalances. The Committee placed weight on the marked rise in house prices since spring 2020 but noted that house price inflation has recently moderated somewhat.

In the Committee’s assessment, the overall outlook and balance of risks imply a continued expansionary monetary policy stance. Further easing of Covid-related restrictions will help a return to more normal economic conditions. This suggests that it will soon be appropriate to raise the policy rate from the current level.

The policy rate forecast implies a gradual rate rise from autumn 2021. The rate path is slightly higher than in the March Report. Capacity utilisation is projected to exceed a normal level towards the end of 2021. Unemployment is projected to decline further and return to pre-pandemic levels in the course of 2022. Underlying inflation is projected to edge down over the next half-year, before rising to 1.6% towards the end of 2024. If the economic outlook changes, the policy rate forecast will also be adjusted.

The Committee decided unanimously to keep the policy rate unchanged at 0%. In the Committee’s current assessment of the outlook and balance of risks, the policy rate will most likely be raised in September.

Øystein Olsen Ida Wolden Bache Ingvild Almås

Jeanette Fjære Lindkjenn (absent) 16 June 2021

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PART 1 MONETARY POLICY

LOWER INFECTION RATES, HIGHER VACCINATION COVERAGE AND GRADUAL REOPENING

Global infection rates have edged lower in recent weeks. Infection rates in Norway are now clearly lower than at the peak in March, and the reopening of society is underway.

The near-term economic outlook for Norway and its trading partners will largely depend on the pace of further reopening. This Special Feature provides a further account of the key assumptions regarding infection rates, vaccination and Covid-related restrictions underlying the economic projections in this Report. To the extent possible, the assump- tions rely on projections from the health authorities and signals from other government bodies.

No new infection peaks in 2021

Infection rates in Norway have fallen sharply since the end of March. As restrictions are eased, there may be periods of temporarily higher infection rates. Nevertheless, it is assumed that no outbreaks will occur that require a retightening of national Covid-related restrictions, even if some restrictions may be tightened locally.

The number of hospitalisations has long tracked developments in infection rates relatively closely. As younger age groups are vaccinated, hospitalisations will likely decline inde- pendently of infection rates. This means that the gradual reopening of society could continue, even in the face of somewhat higher infection rates.

The number of new cases has fallen in the US, euro area and Sweden since the end of April. Infection rates in the UK are still low, but the spread of the Delta variant has led to higher infection rates in recent weeks. Nevertheless, major outbreaks elsewhere in the world have led to higher-than-expected total infection rates. Declining infection rates are expected ahead, broadly in line with the assumptions in the March Report.

Vaccination coverage on the rise

So far, about 35% of the Norwegian population has received a first vaccine dose, and risk groups are now nearly all fully vaccinated. It is assumed that everyone aged 18 and over will have been offered a first dose by mid-August, well in line with the assumptions in the March Report. At the same time, it appears that fully vaccinating the adult popu- lation will take somewhat longer than expected earlier. The assessment of the vaccination outlook is based on the moderate scenario published by the Norwegian Institute of Public Health (NIPH) on 28 May and new information about vaccine deliveries up to and including 11 June.

The projections in the March Report assumed the use of the AstraZeneca and Janssen vaccines, which have now been removed from the national vaccination programme. On the other hand, Norway is receiving more doses of the Pfizer vaccine than expected.

A number of studies suggest that the mRNA vaccines (Pfizer and Moderna) provide a greater degree of protection after one dose than the AstraZeneca and Janssen vaccines with a full course. Studies also document adequate protection against transmission. The vaccination programme envisaged in this Report is assumed to have about the same transmission-reducing effect as the vaccination programme projected in the March Report.

For Norway’s advanced economy trading partners, it is assumed that the adult population will be vaccinated in the course of autumn 2021, the same as assumed in the March PART 1: MONETARY POLICY

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Report. On the other hand, in emerging economies, there are prospects that vaccination will take longer than previously expected.

Gradual reopening

Covid-related restrictions were tightened both locally and nationally in response to the resurgence in infection rates in March. In April, the Government launched a national plan to reopen society in phases, conditioned on developments in infection rates, disease burden and vaccination coverage. On 27 May, the Government implemented phase 2 of the reopening plan. Many local restrictions have also been eased, and more shops and restaurants have reopened. Except for somewhat tighter entry restrictions and an exten- sion of the recommendation to work from home, the level of restrictions has been broadly as expected in March.

Further normalisation is assumed through summer, with the final phase (phase 4) of the national reopening plan beginning by the end of August. In line with signals from the authorities, some restrictions on international travel and large cultural events are still expected until the end of the year. The assessments of the pace of reopening for the latter half of 2021 are little changed from March.

Among Norway’s advanced economy trading partners, Covid-related restrictions overall have been somewhat tighter than assumed in the March Report, but most countries are now reopening. Gradual normalisation is assumed through summer, with an easing of restrictions following broadly the same path as assumed in the March Report.

Continued substantial uncertainty

There is still substantial global uncertainty surrounding infection rates and the pace of vaccination, and hence the phasing-out of Covid-related restrictions. High infection rates in many places, combined with low vaccination coverage, imply a persistent risk of new outbreaks. New variants of the virus may also result in a surge in infection rates in advanced economies and a reimposition of restrictions. Even though existing vaccines have so far proved effective against new variants, it cannot be ruled out that today’s vaccines will be less effective against potential novel strains.

Nevertheless, in Norway and a number of other Western countries, the outlook for the latter half of 2021 is somewhat less clouded than in March. Both infection rates and the pace of vaccination have been broadly as expected, and the range of possible near-term outcomes has narrowed. In addition, the vaccines have so far proved to provide adequate protection against transmission.

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1 The global economy

Owing to high Covid-19 (Covid) infection rates and strict Covid-related restrictions in many countries, economic activity among Norway’s trading partners stagnated in winter. Vaccination and an easing of Covid-related restrictions are expected to boost growth among trading partners in the quarters ahead. GDP will likely have returned to pre-pandemic levels in the course of autumn. Overall consumer price inflation has risen sharply in many countries, but there are still prospects for moderate underlying inflation in the years ahead. Market-implied rates indicate expectations of very low interest rates among trading partners for some time ahead.

Vaccination and easing of Covid-related restrictions lift growth

Trading-partner GDP growth was weak at the end of 2020, and the level of activity was approximately unchanged in winter. Last autumn’s strict Covid-related restrictions were largely retained in 2021 Q1. Businesses in the food service and hotel sectors, among others, had to remain closed in most European countries, and in many places curfews were maintained and public events banned. In the euro area and the UK, GDP fell between 2020 Q4 and 2021 Q1, although less than projected in the March Monetary Policy Report.

US growth gained momentum on the back of direct government payments to a large number of households in March. Overall trading partner GDP growth in 2021 Q1 was stronger than projected in the March Report.

There have been new infection peaks in a number of countries since the March Report.

The number of new cases has fallen in the US, euro area and Sweden since the end of April. Reopening has started in many countries. In the UK, restrictions have been relaxed in several stages, although from a very strict level. The reopening of shops contributed to strong growth in household goods purchases in April (Chart 1.1). In other European countries, shops and restaurants gradually reopened in May. These relaxations are expected to contribute to strong GDP growth among advanced economy trading partners in the quarters ahead. In a number of emerging economies, infection rates increased in spring 2021 and Covid-related restrictions were tightened. The rise in cases was particularly

Chart 1.1 Sharp rise in goods consumption Retail trade. Index. February 2020 = 100

Jan-19 May-19 Sep-19 Jan-20 May-20 Sep-20 Jan-21

75 80 85 90 95 100 105 110 115 120

PART 1: MONETARY POLICY

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high in India, and the healthcare system came under intense pressure. In recent weeks, infection rates in India have fallen.

Among Norway’s advanced economy trading partners, vaccination is well underway.

Over 50% and 60% of the US and UK population have respectively received their first vaccine dose (Chart 1.2). This share is around 45% in a number of other European countries. The pace of vaccination has increased in the euro area since the end of April, but has slowed in the US despite ample vaccine availability.

Since the March Report, progress in vaccine coverage, the easing of Covid-related restric- tions and signs of rebounding growth have fuelled risk appetite in financial markets.

Together with prospects for continued expansionary monetary and fiscal policies, this has led to further gains in advanced economy equity markets. Long-term interest rates have edged down in the US, while they have shown little change in the euro area. Risk premiums for high-yield corporate bonds are somewhat lower than in March.

Policy rate expectations among Norway’s main trading partners have fallen a little since the March Report, especially in the US. Market-implied rates now indicate expectations of higher policy rates in 2023 in a number of countries (Chart 1.3). Large central banks Chart 1.2 Faster pace of vaccination in Europe

Share of population vaccinated with first dose. Percent

Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21

0 10 20 30 40 50 60 70

US Germany UK Sweden Norway France Italy Denmark Spain

Chart 1.3 Unchanged policy rates for some time ahead Policy rates and estimated forward rates in selected countries. Percent

2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 0

1 2 3 4 5 6

0 1 2 3 4 5 6

Forward rates MPR 2/21 Forward rates MPR 1/21

Sources: Bloomberg, Refinitiv Datastream and Norges Bank

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PART 1 MONETARY POLICY / SECTION 1

have not communicated material changes in monetary policy and are signalling continued very expansionary policies for some time ahead.

Under the assumptions in this Report, a substantial share of the adult population in advanced economy trading-partner countries will be fully vaccinated in the course of autumn and the reopening among trading partners will continue as planned (see box on page 11).

Expansionary monetary and fiscal policies are having a positive impact on growth in most countries. In the US, substantial government rescue packages are providing strong fiscal stimulus in 2021. Trading partner GDP growth is projected at over 5% in 2021 and 4% in 2022 (Annex Table 1). The projection for GDP growth in 2021 has been revised up from the March Report 2021. Conditioned on this path, trading partner GDP will have returned to pre-pandemic levels in the course of autumn 2021 (Chart 1.4). Trading partner imports are projected to increase by over 7% in 2021.

Capacity utilisation is projected to be lower than normal at the beginning of the projection period, then to be slightly higher than normal in the course of 2022 and to the end of the projection period. We still assume that the pandemic is contributing to reducing potential output somewhat through lower productivity and a decline in potential employment.

Higher underlying inflation

The pandemic has contributed to unexpected price rises for some goods and services.

Underlying inflation in the euro area rose surprisingly sharply in January, but has since fallen back. In the US, underlying inflation rose markedly in April and May. The sharp rise in inflation reflects higher prices for used cars and air travel, among other things. Under- lying inflation in the US, the euro area and the UK has in recent months been higher than projected. The rapid recovery in goods consumption and global business investment in the second half of 2020 led to a sharp rise in prices for industrial metals and inputs in the manufacturing sector in most countries. Higher producer and commodity prices and higher freight rates will likely continue to put upward pressure on some goods prices in the near term. The fall in prices for goods and services in 2020 will also push up 12-month inflation in the latter half of 2021.

Short-term and long-term inflation expectations have both continued to increase since the March Report. Market-implied measures of inflation expectations indicate some prob- ability of persistently high inflation in the years ahead, but long-term inflation expectations still appear to be well anchored in both the US and the euro area (Chart 1.5). In the coming Chart 1.4 GDP back at pre-pandemic levels during autumn 2021

GDP for trading partners. Index. 2019 Q4 = 100

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 85

90 95 100 105 110

85 90 95 100 105 110

Projections MPR 2/21 Projections MPR 1/21 Projections MPR 4/19

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years, underlying inflation in the US is expected to be close to 2.5%, but somewhat below the inflation targets in the euro area and Sweden. The projections for trading partners as a whole for 2021 and 2022 have been revised up from the March Report.

Producer prices for consumer goods imported to Norway, in foreign currency terms, increased in late autumn 2020 as a result of a sharp rise in a number of commodity prices.

Since the March Report, the rise in producer prices has been higher than expected, par- ticularly for food and audio-visual equipment. The projection for 2021 has been revised up considerably (Annex Table 1).

Considerable uncertainty about the economic consequences of the pandemic There is considerable uncertainty surrounding the global economic outlook. Develop- ments will depend on factors such as the pace of vaccination, infection rates, Covid-related restrictions and the prevalence of virus variants (see box on page 11). In addition, owing to the pandemic, a larger share of the population may have dropped out of the labour force and potential growth further ahead may therefore be lower than assumed in this Report. Growth may be higher than projected if the sharp rise in household saving during the pandemic reverses sooner and to a further extent than currently envisaged. Price and wage inflation may then become entrenched at a higher level than currently projected.

Higher oil and gas prices

Oil spot prices are now a good USD 70 per barrel. Futures prices at the end of 2024 are around USD 60. Both spot and futures prices are somewhat higher than at the time of the March Report. Global oil consumption is expected to pick up as Covid-related restric- tions are eased and economic activity normalises. At the same time, OPEC+ is expected to gradually reverse the production cuts introduced in spring 2020 and oil production in other countries is expected to rebound, following the fall in production in 2020.

Spot and futures prices for European gas have continued to rise and are considerably higher than at the time of the March Report. A cold start to 2021 substantially reduced European gas inventories. European gas prices are also being pushed up by the rise in prices for Asian liquefied natural gas (LNG). In addition, a marked rise in emission allow- ance prices in Europe (EU ETS) favours gas over coal in the power sector. Coal prices have also risen substantially.

Oil and gas futures prices for the years ahead are now markedly higher than at the beginning of 2020. This indicates higher prices for Norwegian petroleum exports in the period to 2024 than expected before the pandemic.

Chart 1.5 Higher inflation expectations

Long-term market-based inflation expectations. Five-year five years ahead. Percent

2010 2012 2014 2016 2018 2020

0 1 2 3 4

US Germany

Sources: Bloomberg and Norges Bank

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2 Financial conditions

Interest rates on loans to households and corporations are at historically low levels. Residential mortgage rates have shown little change in recent months while interest rates on loans to corporations have declined due to lower money market premiums. From the latter half of 2021, lending rates are projected to move up in pace with a rise in the policy rate.

The krone exchange rate is broadly unchanged since the March 2021 Monetary Policy Report. The krone is projected to appreciate in the period ahead.

2.1 Interest rates

Prospects for higher mortgage rates

Mortgage rates have reached historically low levels following the interest rate decline in spring 2020 (Chart 2.1). At end-April, the average rate was 1.84%, slightly lower than at the start of the year. Some banks have recently adjusted the interest rate on certain mortgages, but quoted rates indicate little change overall since March.

The average mortgage rate is expected to start rising in autumn owing to a rise in the policy rate. Later in the projection period, the mortgage rate climbs gradually in pace with a rise in the policy rate. In 2024, the mortgage rate is projected at 3.0%.

It is assumed that the rise in the policy rate does not pass through fully to banks’ mortgage rates partly because mortgage spreads, ie the spread between the mortgage rate and money market rate, have widened since the policy rate was lowered in March 2020.

With a rise in the policy rate ahead, the spread on mortgages is expected to approach the levels prevailing prior to the policy rate cuts in March 2020.

Chart 2.1 Prospects for higher lending rates Percent

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

0.5 1 1.5 2 2.5 3 3.5 4

0 0.5 1 1.5 2 2.5 3 3.5 4

Policy rate Three-month money market rate Mortgage rate Projections MPR 2/21 Projections MPR 1/21

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Lower money market premium

Three-month Nibor, which reflects market policy rate expectations for the next three months and a risk premium, has moved down since the March Report. That occurred against the background of a fall in the risk premium, mainly owing to prospects for higher structural liquidity (see box on page 20). The premium has fallen more than projected in March. During autumn, structural liquidity is expected to fall, resulting in a renewed rise in the premium. The premium is projected to average close to 0.35 percentage point in Q3 and to remain around that level to the end of the projection period (Chart 2.2).

Banks pay a risk premium over Nibor on their wholesale funding. Premiums on senior bank bonds and covered bonds are broadly unchanged since the March Report.

Market policy rate expectations have shown little change since March. Market-implied rates indicate that the policy rate will be raised from today’s level in the course of autumn.

Long-term rates with maturities of five to ten years reflect expected money market rates and are important for households and corporations that prefer fixed-rate loans. In line with US government bond yields, Norwegian long yields have edged down slightly since the March Report (Chart 2.3).

Chart 2.2 Lower money market premiums Percentage points

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

0.2 0.4 0.6 0.8 1

0 0.2 0.4 0.6 0.8 1

Projections MPR 2/21 Projections MPR 1/21

Chart 2.3 Long-term rates have edged down slightly Yields on 10-year government bonds in selected countries. Percent

Jan-20 Mar-20 May-20 Jul-20 Sep-20 Nov-20 Jan-21 Mar-21 May-21 0

0.5 1 1.5 2

0 0.5 1 1.5 2

US Germany UK Sweden Norway

Source: Bloomberg

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Banks’ interest rates on loans to corporations are normally linked to three-month Nibor.

Against the background of the decline in the money market rate, interest rates on corporate loans both from banks and the bond market have also declined since March. Risk premiums on new corporate bond issues are broadly unchanged since March.

Another source of corporate funding is the equity market. Like equity indexes in many other countries, the benchmark index on Oslo Børs declined markedly in spring 2020, followed by advances to historically high levels through autumn 2020 and winter 2021.

Since the March Report, the Oslo Børs benchmark index has advanced further.

2.2 Krone exchange rate Unchanged krone

The krone exchange rate, as measured by the import-weighted exchange rate index I-44, has shown little change since March. The movement in the krone has been consistent with that projected in the March Report. After falling to record-weak levels during the market turbulence last year, the krone is now slightly stronger than prior to the pandemic.

The krone appreciation over the past year occurred concomitantly with a rise in oil prices, a wider interest rate differential against trading partners and reduced financial market uncertainty. Looking ahead, the krone is projected to strengthen further (Chart 2.4), on the back of a gradual widening of the interest rate differential against trading partners.

There is considerable uncertainty regarding movements in the krone exchange rate ahead. Positive vaccine news has probably contributed to an improvement in risk senti- ment in global financial markets and to a stronger krone. If global uncertainty continues to subside, the krone may appreciate further. If uncertainty rises, for example owing to vaccine problems or new virus variants, the krone may depreciate.

Chart 2.4 Stronger krone ahead

Import-weighted exchange rate index (I-44) and oil price

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

40 80 120 160

130 120 110 100 90

Oil price (l.h.s.) I-44 (r.h.s.) Projections MPR 2/21 Projections MPR 1/21

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STRUCTURAL LIQUIDITY

Structural liquidity is the level of reserves in the banking system before Norges Bank conducts market operations to supply or withdraw reserves. Structural liquidity is primarily determined by transactions in and out of the government’s account with Norges Bank. When private agents pay direct and indirect taxes to the government, or when the government issues government securities, reserves are transferred from the banks’

accounts with the central bank to the government’s account with the central bank, reducing the quantity of reserves in the banking system. Reserves increase in the oppo- site case, ie when the government transfers money to the public, for example wages, benefits and other transfers, and when government securities mature.

Norges Bank conducts market operations, so-called F-loans and F-deposits, to counter- act daily variations in structural liquidity with a view to maintaining the reserves in the banking system at around NOK 35bn daily.¹ Ahead of periods of lower structural liquidity, banks may nevertheless prefer to procure NOK at longer maturities, resulting in an increase in demand for NOK in the FX swap market. Nibor is designed in a way whereby an increase in the cost of NOK funding via the FX swap market translates into a higher money market premium. On the other hand, when there are prospects for higher structural liquidity, the cost of NOK funding in the FX swap market will fall, which results in a lower money market premium, as has recently been the case.

1 See “Norges Bank’s liquidity policy: Principles and design”, Norges Bank Papers 3/21 (publication forthcoming).

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3 Norwegian economy

Tighter Covid-related restrictions led to a fall in mainland GDP in 2021 Q1 and a rise in unemployment. Infection rates have since come down, and the authorities have begun a gradual reopening of society. Recently, unemployment has fallen substantially.

There is still uncertainty surrounding the economic recovery ahead, but given how the pandemic now seems to be evolving, economic activity is expected to show a strong rebound in the coming months. Household consumption will likely rise sharply ahead, and capacity utilisation is projected to return to a normal level in the course of autumn. There are prospects that unemployment will continue to fall in the period to autumn 2022 and remain low until the end of the projection period.

Underlying inflation has slowed in recent months and is now below the inflation target. The reopening is creating uncertainty about price and wage inflation ahead, but price inflation is likely to slow further into 2022. Inflation is expected to pick up again further ahead and is projected to reach 1.6% at the end of 2024.

3.1 Economic developments

When the pandemic hit in spring 2020, activity in the Norwegian economy fell sharply (Chart 3.1) and unemployment increased markedly. As the spread of Covid was brought under control and restrictions were eased in the period to summer 2020, economic activity also started to recover and unemployment declined. The economic recovery stalled through autumn when infection rates again flared up. Higher infection rates and tighter Covid-related restrictions contributed to a renewed fall in activity in 2021 Q1 and more workers were furloughed.

Mainland GDP fell by 1.0% between 2020 Q4 and 2021 Q1, with the sharpest decline in services particularly affected by Covid-related restrictions, such as culture, entertain-

Chart 3.1 Covid-related restrictions have hampered growth

GDP for mainland Norway. Contribution to monthly growth. Seasonally adjusted. Percentage points

Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21 Jul-21 0

2 4

0 2 4

Manufacturing and extraction services Other industries

Private services Public services Indirect taxes Mainland GDP

(22)

ment, hotels, restaurants and transport. The shutdown of shops and shopping centres in some regions of Norway weighed on retail trade activity. Closed borders affected firms’ access to foreign labour, which has likely dampened output in construction and manufacturing. Economic activity rebounded slightly in April, but GDP was still 2.6%

lower than in February 2020.

Infection rates have recently declined and the authorities have relaxed Covid-related restrictions. Around 35% of the population have received their first vaccine dose, and there are prospects that all adults aged 18 and over will have been offered a first dose by mid-August. The reopening of society is expected to give a boost to economic activity ahead. Low interest rates and a continued expansionary fiscal policy are underpinning growth. The recovery is projected to be particularly strong in services that have been hard hit by the restrictions. This is in line with information from contacts in Norges Bank’s Regional Network, who report expectations of solid growth in all sectors over the next six months.

Growth is expected to rebound strongly through summer, and mainland GDP is projected to increase by 0.8% in 2021 Q2 and 3.2% in Q3. Activity in the mainland economy will then have returned to its pre-pandemic level in Q3 (Chart 3.2). Annual growth in mainland GDP is projected at 3.8% in 2021.

Chart 3.2 Higher growth prospects

GDP for mainland Norway. Seasonally adjusted. Index. Q4 2018 = 100

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 92

96 100 104 108 112

92 96 100 104 108 112

Projections MPR 2/21 Projections MPR 1/21 Projections MPR 4/19

Chart 3.3 Household consumption will boost growth in the coming years GDP for mainland Norway. Contribution to annual growth. Percentage points

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

2 4 6 8

0 2 4 6

8 Household consumption Housing investment Public spending Business investment Petroleum investment Exports

Imports and inventories Mainland GDP

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Strong growth in the mainland economy is projected to continue in 2022, followed by a slowing in 2023 and 2024 (Chart 3.3). After a long period of limited consumption opportunities, higher household spending is the main driver behind growth in the Norwegian economy. Further economic recovery among Norway’s trading partners will boost exports in the period ahead. Towards the end of the projection period, growth is also supported by solid investment growth as a result of climate change adaptation.

There is still uncertainty regarding the economic outlook. If vaccination problems arise or new variants emerge that are more resistant to vaccines, growth may be lower than projected. On the other hand, if household consumption rises faster than anticipated, growth may be stronger than projected.

Rebound in household demand

Household consumption fell by 4.1% in 2021 Q1, following weak growth in 2020 Q4.

Developments in 2021 Q1 reflect tighter Covid-related restrictions introduced after the turn of the year. Firms in service industries, such as hotels and restaurants, were particularly hard hit by the restrictions in 2020, while the impact on retail trade was less severe. As a result, household demand shifted from services to goods. However, in January 2021, retail trade was also hit by restrictions when most shops and warehouses in a number of municipalities in Norway were closed. As a result, consumption of both goods and services fell in 2021 Q1 (Chart 3.4).

Card transaction data for debit and credit cards for a large share of the population indicate that services and goods consumption picked up in May. Further reopening is expected to provide a substantial boost to services consumption through summer and autumn.

This is in line with information from Regional Network contacts, where household-oriented enterprises expect demand to pick up markedly over the next six months. Household spending abroad will likely remain at a low level in the coming period. Thereafter, an easing of travel restrictions through autumn will likely boost household spending abroad towards the end of 2021. Growth in goods consumption is expected to slow through autumn as society reopens further. See box on page 36 for a further discussion on potential developments in household consumption as society reopens.

Due to a long period of limited spending opportunities, combined with low interest expenses and expanded government support schemes, households have accumulated substantial savings (Chart 3.5). The high level of savings provides room to increase consumption considerably in the years ahead, which is reinforced by prospects for higher

Chart 3.4 Reopening of society pushes up services consumption ahead

Goods and services consumption. Constant prices. Seasonally adjusted. In billions of NOK

2019Q1 2019Q3 2020Q1 2020Q3 2021Q1 2021Q3

140 150 160 170 180 190 200

Services consumption Goods consumption Projections MPR 2/21 Projections MPR 1/21

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real disposable income. Household consumption is expected to rise markedly in 2022, before gradually slowing further out in the projection period.

Higher housing investment ahead

Housing market activity has been strong over the past year, with rising house prices, increased new home sales and high existing home sales. Low interest rates stimulate the housing market, and increased remote working and limited consumption opportunities have likely pushed up housing demand and the willingness to pay for housing.

Analyses indicate that the interest rate effect on house prices may be stronger than previously projected (see box on page 42).

House price inflation has slowed in recent months and has been a little lower than pro- jected in the March Report. Against the background of higher interest rates, a normalisa- tion of household consumption patterns and an increase in residential construction, house price inflation is projected to continue to slow ahead (Chart 3.6). See Section 5 for more on housing market developments.

Housing investment fell in 2021 Q1, following a sharp rise towards the end of 2020. New home sales rose through autumn 2020 and have remained at a high level so far in 2021.

Chart 3.5 High savings provide room for consumption growth Household saving ratio excluding dividends. Percentage points

1993 1997 2001 2005 2009 2013 2017 2021

0 2 4 6 8 10 12 14

Projections MPR 2/21

Chart 3.6 Lower house price inflation ahead

Housing investment and nominal house prices. Annual change. Percent

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

5 10 15

0 5 10 15

Housing investment House prices Projections MPR 2/21 Projections MPR 1/21 Projections MPR 2/21 Projections MPR 1/21

Sources: Real Estate Norway, Eiendomsverdi, Finn.no, Statistics Norway and Norges Bank

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The high level of new home sales is expected to push up residential construction and housing investment ahead.

Prospects for higher business investment

The pandemic has had a severe impact on many sectors and has led to a decline in the willingness and ability of many firms to invest. Mainland business investment fell by over 6% in 2020, and investment edged down further in 2021 Q1. Access to public support and loan schemes has eased uncertainties and compensated firms for loss of income during the lockdowns over the past year. This may have curbed the decline in investment.

With a return to more normal economic conditions, the public support schemes are assumed to be phased out in the course of autumn.

Regional Network contacts report improved profitability and are planning to increase investment over the next 12 months (Chart 3.7). Feedback from the Regional Network survey may suggest that investment will be higher ahead than previously envisaged.

Overall, growth in business investment is expected to be close to zero in 2021. Services investment makes the main contribution to holding up investment growth in 2021, countered by lower investment in the power sector.

Investment growth is expected to pick up in the years ahead, on the back of higher capacity utilisation and improved corporate profitability. Increased investment in bat- teries, hydrogen and carbon capture and storage is also expected to boost investment.

See box on page 39 for more details.

Petroleum sector investment fell markedly in 2020, primarily owing to the pandemic, lower oil prices and heightened uncertainty. There are prospects for a decline in petroleum investment in 2021 and into 2022.

The temporary tax reductions for the oil industry give oil companies strong incentives to launch development projects before the end of 2022. In line with this, and owing to the upswing in oil and gas prices, oil companies have signalled that they will launch a number of development projects towards the end of 2022. Petroleum investment is therefore expected to rise markedly in 2023 and 2024 (Chart 3.8). Investment will be pushed up further by oil companies’ plans for substantial investment in electrification projects ahead, driven by the petroleum tax package, oil companies’ ambitions to reduce greenhouse gas emissions and the Government’s plan to increase the carbon tax rate in the period to 2030.

Chart 3.7 Plans for increased business investment

Expected change in business investment the next 12 months. Percent

2015 2016 2017 2018 2019 2020 2021

0 5 10

Manufacturing Oil services Retail trade Services Total

Source: Norges Bank

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Continued export growth

Mainland exports have continued to recover following the decline in spring 2020, increas- ing modestly in 2021 Q1. A further rise is expected, partly owing to higher activity among Norway’s trading partners (Chart 3.9). Travel activity is expected to edge up over summer, before an easing of restrictions likely leads to appreciable growth in travel activity through autumn and in 2022. Oil service exports will likely decline somewhat in 2021, followed by rapid growth in pace with the rise in global petroleum investment.

After rising sharply in autumn 2020, imports fell by more than 6% in 2021 Q1, mainly as result of the fall in imports of cars, machinery and information services. Since the Covid outbreak, imports, like exports, have been affected by the decline in international travel.

As travel restrictions are lifted and domestic demand picks up, imports are expected to increase markedly.

High public spending supports growth in the economy

The Government has implemented extensive fiscal policy measures to mitigate the economic fallout of the pandemic and strict measures to contain it. Support measures have largely been in the form of direct cash transfers to firms and increased income protection for households. Funds have also been appropriated for hospitals, local government and other parts of the public sector that have had to take on additional respon- sibilities to deal with the Covid outbreak. Nevertheless, public purchases of goods and Chart 3.8 Petroleum investment picks up after 2022

Petroleum investment. Constant 2021 prices. In billions of NOK

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

50 100 150 200 250

0 50 100 150 200 250

Exploration and concept studies Shutdown and removal Pipeline transport and onshore activities Fields in production excluding development projects Ongoing and former development projects Wisting and the Noaka area Other new development projects

Chart 3.9 Exports pick up ahead

Exports from mainland Norway. Contribution to annual growth. Seasonally adjusted. Percentage points

2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 0

5 10

0 5

10 Exports from oil services etc Other mainland exports Travel

Exports, mainland Norway

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services have accounted for a smaller share of the support measures than during the 2008–2009 financial crisis. Various public services, such as health and care services, culture and education have also had to reduce their provision of services owing to the lockdowns over the past year. As a result, growth in public sector demand was fairly low in 2020 despite higher public spending.

Amid higher infection rates and tighter Covid-related restrictions towards the end of 2020 and into 2021, the scale of support measures has been greater than the Govern- ment assumed in the National Budget for 2021. In the Revised National Budget for 2021, the Government proposes further extensions of existing support schemes. The structural non-oil deficit in 2021 is projected to be 3.7% of the market value of the Government Pension Fund Global (GPFG) in 2021, compared with 3.3% in the March Report.

The spending increase proposed in the Revised National Budget is largely related to the extensions of the business and household support schemes. Further support to households will help quicken a rebound in consumption when restrictions are eased, while an increase in transfers to firms may improve business profitability.

The extraordinary support schemes are assumed to be phased out in the course of autumn, in pace with the reopening of society, and this is expected to result in a decrease in the structural non-oil deficit to 3.1% of the market value of the GPFG in 2022 (Chart 3.10). Further out in the projection period, the deficit is assumed to remain close to 3%.

Labour market improves

In the first few weeks after the publication of the March Report, unemployment edged up and was higher than had been expected. Since then, unemployment has moved down markedly following a decline in infections and an easing of Covid-related restrictions.

The number of both fully unemployed and partially unemployed is lower than in March.

At the end of May, close to 184 000 persons were registered as fully unemployed, partially unemployed or job seekers on labour market programmes. Fully unemployed accounted for a seasonally adjusted 3.5% of the labour force. Unemployment has fallen further through June (Chart 3.11). The fall since March is the result of a decrease in both furloughed workers and ordinary unemployed. Unemployment is a little lower than projected in the March Report.

Chart 3.10 Lower growth in public demand in the coming years

Structural non-oil budget deficit and public demand. Share and annual growth. Percent

2015 2017 2019 2021 2023

0 1 2 3 4 5

Budget deficit as a share of the GPFG Projections MPR 2/21 Projections MPR 1/21 Public demand Projections MPR 2/21 Projections MPR 1/21

Sources: Ministry of Finance, Statistics Norway and Norges Bank

MONETARY POLICY REPORT

MONETARY

POLICY REPORT

WITH FINANCIAL STABILITY ASSESSMENT

2 | 21

JUNE

Contents

Countercyclical capital buffer

Decision-making process for Monetary Policy Report 2/21

Monetary policy assessment

1 The global economy

2 Financial conditions

3 Norwegian economy